529 PLAN SAVINGS FEATURES

A 529 plan is a tax-advantaged educational savings account that allows individuals to save money for a beneficiary’s future education costs. A beneficiary can be a child, grandchild, friend, or yourself. Besides saving for future education costs, these plans have many other benefits.

State Income Tax Deduction

Since 529s are state-sponsored plans, many states offer a state income tax deduction for contributions. Each state has different limits, so plan deductibility depends on your residence. Some states allow you to take a deduction even when using another state’s 529 plan.

No Income or Annual Contribution Limitations

Unlike other savings plans, no income limits are associated with 529 plans, and there are no annual contribution limits. However, each state generally sets an aggregate contribution limit for 529 accounts ($500,000 contribution limit per beneficiary for Nebraska’s plan).

It is also important to note that an account owner’s contributions are considered gifts for federal and estate tax purposes and qualify for the annual gift tax exclusion, which is $17,000 per beneficiary in 2023 ($34,000 for married couples). There is an election that allows one to front-load contributions to a plan in a single year without it being considered a taxable gift, but that is beyond the scope of this article.

Investment of Assets 

Another powerful feature is the ability to invest the assets in 529 plans to grow and compound the savings over time. All growth and investment earnings are tax-deferred. Plans generally offer an array of investment options, including target-date funds, which adjust your allocation over time as a beneficiary gets closer to college.

QUALIFIED 529 WITHDRAWALS

One of the major perks of 529 plans is withdrawals are free from federal and state income taxes as long as the funds are used for qualified educational expenses associated with college or other postsecondary institutions. Examples include:

• Tuition
• Fees
• Room and Board
• Textbooks
• Necessary Supplies and Technology

Congress recently approved using up to $10,000 of 529 funds per year per beneficiary to pay for K-12 tuition expenses. However, Nebraska’s 529 plan laws are different, and there are some specific implications that you should be aware of.

It is also possible to withdraw up to $10,000 tax-free from 529 plans to pay down student loans. The $10,000 allowed for student loans is a lifetime limit per beneficiary, and there are other specific considerations. Additionally, you can change the beneficiary of a 529 plan at any time to another family member of the beneficiary or roll over a plan into another family member’s existing plan.

NONQUALIFIED 529 WITHDRAWALS

A common concern with 529 plans is what to do if the beneficiary does not need all the funds. Having excess money saved can result from the beneficiary receiving a scholarship, not attending college, overestimating the cost of tuition, or other reasons.

Before the passage of the SECURE 2.0 Act, if 529 funds weren’t used for qualified education expenses, withdrawals would be subject to income taxes and a 10% penalty on the earnings portion of the account. Additionally, nonqualified withdrawals in Nebraska are subject to the recapture of any state tax deductions previously taken.

You generally can’t escape the income taxes on nonqualified withdrawals, but there are a few exceptions to the 10% penalty. Examples of exceptions include beneficiaries receiving tax-free scholarships or attending a U.S. military academy.

SECURE 2.0 ACT NONQUALIFIED 529 WITHDRAWAL PROVISIONS

The SECURE 2.0 Act created the option to use a portion of the excess funds from overfunded 529 plans for retirement savings.

A 529 plan beneficiary can transfer the funds directly into a Roth IRA without incurring taxes or penalties beginning in 2024. This will allow you to reposition excess 529 funds into tax-advantaged Roth IRAs.

Limits and conditions apply for the transfers to be valid:

• The beneficiary of the 529 plan and the owner of the Roth IRA must be the same person.
• The 529 plan must have been established for at least 15 years.
• The lifetime amount that can be rolled over is $35,000 per beneficiary.
• Transfers are subject to annual Roth IRA contribution limits and count against annual contribution caps (currently $6,500 in 2023), meaning it would take several years of transfers to reach the $35,000 limit.
• Beneficiaries must have earned income at least equal to the rollover amount in the year of a rollover.
• Income limitations for Roth IRA contributions do not apply to these rollovers. Therefore, there is no income cap on the ability to do these, unlike the cap on making direct Roth IRA contributions.
• Contributions to the 529 plan in the last five years (and associated earnings) are ineligible for the tax-free transfer.

These new provisions provide an excellent planning opportunity for families with excess 529 funds or who are concerned about overfunding 529 plans. It enables much greater flexibility when saving for future education costs by removing the need to predict exactly how much the future expense will be. There are still a few specifics that aren’t entirely clear yet and will likely need to be clarified by Congress before 2024. Before implementing this strategy, you should consult a financial advisor or tax professional.

Contact us with questions or learn about our financial planning services.

IMPORTANT DISCLOSURE INFORMATION